Why This Case is Important: The Court of Chancery opinion in Obeid v. Hogan, C.A. No. 11900-VCL (Del. Ch. June 10, 2016), will be cited often as a reference guide for fundamental principles of Delaware corporate law and LLC law, including the following: (1) even in derivative litigation when a stockholder has survived a motion to dismiss under Rule 23.1, for example, in which demand futility is an issue, pursuant to DGCL Section 141, the board still retains authority over the “litigation assets” of the corporation, and if truly independent board members exist, or can be appointed, to create a special litigation committee (SLC), it is still possible for the SLC, under certain circumstances, to seek to have the litigation dismissed; (2) if an LLC Operating Agreement adopts a form of management and governance that mirrors the corporate form, one should expect the court to use the cases and reasoning that apply in the corporate context; (3) even though most readers will be familiar with the cliché that LLCs are creatures of contract, the Court of Chancery underscores the truism that it may still apply equitable principles to LLC disputes; (4) a bedrock principle that always applies to corporate actions is that they will be “twice-tested,” based not only on compliance with the law, such as a statute, but also based on equitable principles.
The facts of this case are recited in a comprehensive manner in the court’s opinion, along with scholarly analysis, but for purposes of this short blog post, I will provide bullet points.
- This opinion provides a roadmap for how a board should appoint a special litigation committee with full authority to seek dismissal of a derivative action against a corporation. See pages 30 to 32.
- The LLC agreement in this case imported the language of Section 141(c) of the Delaware General Corporation Law regarding the composition of a special litigation committee of the board. This LLC agreement adopted a form of governance that mirrored the management of a corporation and included a board of directors. Therefore, the court applied a corporate law analysis, see footnote 5, including an exemplary explanation of the seminal Delaware Supreme Court decision in Zapata that articulated the controlling corporate law principles in connection with special litigation committees. See page 16.
- The Zapata case was applied to explain that even if a majority of the board is disqualified by lack of independence, it can still delegate its power to a disinterested committee with full board power to decide to move to dismiss a derivative suit filed against the corporation. This may require that additional members of the board be appointed, if possible, who are truly independent. See pages 22 and 23.
- The court explained that the SLC has the burden to demonstrate its independence and good faith and that it conducted a reasonable investigation. Moreover, the court has discretion to make its own judgment regarding the soundness of the decision of the SLC. See pages 24 and 25. This opinion provides an excellent explanation of the concept of the SLC.
- This may be somewhat controversial in some circles, but the court explained its reasoning for why it still has the power and authority to apply equitable principles to LLC disputes. See page 11 at footnote 2. See also a recent article on this topic by Prof. Mohsen Manesh, entitled “Equity in LLC Law“, which addresses this concept and includes a discussion of another recent Chancery decision, In Re Carlisle, Etc., announcing the same principle.
- The foregoing reminder of the court’s equitable powers is related to a bedrock principle that all corporate acts are “twice tested,” based on compliance with both the law and equity. See footnote 12 and accompanying text.
In closing, we are happy to note that the scholarship of a very good friend of this blog, and nationally recognized corporate law scholar, Professor Stephen Bainbridge, was cited in this court opinion at footnote 16. It is not uncommon for Professor Bainbridge’s scholarship on corporate law issues to be cited by the Delaware courts, but it is still worth noting. [In addition to this case, the good professor was also cited in another Chancery decision recently, in the matter styled: Pell v. Kill, No. 12251-VCL, 2016 WL 2986496, at *16 (Del. Ch. May 19, 2016).]
Supplement: Professor Bainbridge provides erudite commentary on this case, and he kindly quotes this post. He also provides excerpts of client memos on this case from the Richards Layton and Morris Nichols firms.